Steering Clear of Emotional Investing

Financial markets work in cycles, and so can investors’ emotions. No matter what you may hear in business news or from friends about the “next big stock tip,” it’s important to stay focused on the long term. Doing so will help you avoid emotional investment traps that are driven by the cyclical nature of markets.

By the time average investors hear about a “hot tip,” it is likely old news for people closer to the markets. The result? Many investors end up chasing returns that have already been achieved, leaving them with investments of questionable value.

Greed and fear can put portfolios at risk

Chasing returns can have a negative impact on long-term results. For instance, investors will often feel compelled to jump in as the market heats up—at its peak—and buy high. To avoid more losses, investors will often retreat and sell low—near or at the market’s bottom. In turn, they miss out as the market begins to climb again.

The following chart demonstrates how investors tend to chase returns, buy high and sell low en masse. During the Financial Crisis of 2007-2008, you can see that inflows in equity mutual funds rose before the crisis hit. We all know the results: the bubble burst and investors sold their stocks out of fear and desperation as the market sank. For many, this was a permanent loss of capital. Of course, the markets eventually enjoyed a rebound—and many “shell-shocked” investors watched from the sidelines while the professionals reaped the benefits. Remember, sometimes inaction can be the best course of action. Missing out on some of the best days in the market can be costly to your portfolio.

Advisors keep you on track

To avoid such emotional-investment traps, remember that the cycles of the market and investors’ reactions tend to repeat, over and over, so it’s important to stay focused on the long term. Above all, working with a professional advisor is important. He or she can help you build, and stick to, a strong, long-term financial plan, which will ensure that you stay disciplined throughout the inevitable ups and downs of the market.